Australia: Future of Financial Advice Reforms

The Future of Financial Advice reforms are placed to take effect
from 1 July 2012. The impetus for the changes is improved
transparency and increased access to financial advice. Both were
concluded to be necessary by the Federal Government's 2009
'Ripoll Inquiry'. Following the introduction into
Parliament of Bills seeking to implement the reforms, the question
is whether the legislation will be enough to meet the 'Ripoll
Inquiry's' focus of rehabilitating the public perception of
the industry.

In our June 2011 Insurance & Financial Services
Bulletin, we outlined the Federal Government's
proposed Future of Financial Advice (FOFA) reforms. Since then, the
Federal Government has released, in two separate tranches, Bills
seeking to implement these reforms. On 13 October 2011, the
Corporations Amendment (Future of Financial Advice) Bill 2011 was
introduced into Federal Parliament. This was followed on 24
November 2011 by the introduction into Parliament of the
Corporations Amendment (Further Future of Financial Advice
Measures) Bill 2011. Both Bills have since been referred to the
Parliamentary Joint Committee on Corporations & Financial
Services.

The FOFA reforms were largely driven by allegations of conflict
of interest which featured in a number of the high profile
Australian corporate collapses arising out of the GFC. The
underlying objective of the reforms is cited in the Explanatory
Memorandum as "building trust and confidence in the financial
planning industry".

To this end, the FOFA legislation proposes key amendments of a
'best interests' duty, 'opt-in' disclosure
requirements and increased watchdog powers for the Australian
Securities and Investments Commission (ASIC).

Best Interests

Currently, the Corporations Act 2001 (Cth) (the
Act) does not require a financial adviser to act in the
best interests of the client or to prioritise a client's
interests over their own. In practice, this has meant that an
advice need only meet the requirement of appropriateness (s 945A)
and that the necessary disclosures be made by the "providing
entity" (the licensee) (Part 7.7). These necessary disclosures
are currently limited to issues such as the provision of a
Financial Services Guide (s 941B) and Product Disclosure Statement,
the requirement to warn that a general advice does not take account
of a client's objectives (s 949A) and also to warn where an
advice is based on incomplete or inaccurate information (s
945B(1)).

The new legislation introduces a more onerous framework
requiring obligations for all individuals who provide personal
advice to "act in the best interests of the client in relation
to the advice" (s 961B(1)). Relevantly to basic banking and
general insurance products, this can be established through
compliance with the first three of the following seven steps:

identifying the objectives, financial situation and needs of
the client;

identifying the client's circumstances relevant to the
subject matter of the advice sought – being termed in the
industry as the "know your client rule";

making reasonable inquiries to obtain complete and accurate
information;

assessing whether the provider has the expertise to provide the
advice sought and, if not, declining to provide the advice;

conducting a reasonable investigation into and assessing any
financial products it considers recommending – the
"know your product rule";

basing all judgements in advising the client on the
client's relevant circumstances; and

taking any other steps that would reasonably be regarded as
being in the best interests of the client, given the client's
relevant circumstances.

It is acknowledged in the Explanatory Memorandum that these
steps are based on the current regime and what is expected of
licensees. Under the new legislation, whether a provider has acted
in the best interest of the client will also be tested according to
what would "objectively and reasonably" be considered
appropriate for the client (s 961G) – this is also the
current test relevant to "appropriateness" under s
945A.

In addition to the 'best interests' duty, s 961J of the
new legislation will also require the provider to give priority to
the client's interests when providing the advice. There is no
existing statutory duty to do so.

Ongoing fee arrangements

The current regime allows advisers to obtain ongoing 'trail
fees' from their clients' investment portfolios in lieu of
a higher initial commission or fixed fee for service. Despite
receiving ongoing remuneration for these services, an adviser has
no corresponding obligation to provide an ongoing service. This has
led in some instances to disengaged clients paying ongoing fees for
little or no service.

Notwithstanding public criticism, the Federal Government
acknowledges in the Explanatory Memorandum accompanying the Bills
that trail commissions have a role to play in the financial
services industry and subsequently, these have not been entirely
abolished. The legislation does however seek to redress the
adviser/consumer imbalance by imposing two separate disclosure
requirements on advisers providing advice to a retail client and
proposing to charge an ongoing advice fee:

an annual fee disclosure statement to the client (s 962G)
detailing advice fee and service information for both the previous
and upcoming 12 months (s 962H); and

an additional 'opt-in' renewal notice to the client
every two years (s 962K).

For ongoing fee arrangements, the client is also entitled to
'opt-out' or terminate the arrangement at any time (s
962E). Significantly, in the case of the renewal notice, where the
client opts not to renew (s 962M) or simply does not respond to the
renewal notice (s 962N), the arrangement ceases and an ongoing
advice fee can no longer be charged to the client. The opt-in will
apply to new clients from 1 July 2012.

ASIC powers

The legislation also enhances the regulatory powers of ASIC to
supervise the financial services industry through changes to its
licensing and banning powers.

Under the current legislation, the threshold for entry into the
licensing regime is relatively low whereas the threshold for
cancelling licences was acknowledged in the 'Ripoll
Inquiry' to be comparatively high. The laws contained in the
first of the two Bills will enable ASIC to refuse or cancel a
licence if it believes a licensee is "likely to contravene its
obligation" (s 915C(1)(aa) rather than the current requirement
to establish that a licensee "will not" comply. The
Explanatory Memorandum refers to these provisions as "an
enhancement of ASIC's powers to deal with unscrupulous
operators."

The legislation will also give ASIC the capacity to act at an
earlier stage if it has concerns about either individuals or a
licensee (as opposed to only a licensee), enabling it to ban a
person who it "has reason to believe" is "not of
good fame or character" or "not adequately trained or not
competent to provide a financial service" (s 920A(1)(c ).
While the legislation sets out a limited number of circumstances
that would tend to suggest a person is "not of good fame or
character", including the conviction of an offence, suspension
or cancellation of an Australian Financial Services licence or the
making of a banning or disqualification order under Division 8 of
the Act, the proviso "any other matter ASIC considers
relevant" makes it clear that ASIC's powers under the new
regime are intended to be broad-sweeping. In fact, the legislation
is now being criticised by some industry bodies as giving ASIC too
much discretion. There have also been demands for more certainty as
to how ASIC intends to prove a licensee is ''likely
to'' breach its obligations

.

Implications

The reforms seek to expand the regulatory framework in which
financial providers are currently operating. Insofar as the
'best interests' component has not previously been codified
and the new legislation targets individuals as opposed to licensees
which are currently regulated, these reforms could lead to
increased levels of exposure. However, the 'best interests'
threshold does not appear unduly high, requiring compliance in some
cases with only the first 3 of 7 steps which are based on current
practice, calling into question the extent of the claims impact
which will be felt.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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